The author is a Forbes contributor. The opinions expressed are those of the writer.

Loading ...

Loading ...

This story appears in the {{article.article.magazine.pretty_date}} issue of {{article.article.magazine.pubName}}. Subscribe

In recent months, loan market players have grown more optimistic about the near-term default outlook, according to LCD’s latest quarterly buyside poll, which was conducted in early September.

On average, managers have reeled in their 2012 default rate forecast to 1.54%, from 1.77% in June and 1.9% in December. Likewise, managers tamped down their 2013 forecast to 2.69%, from 2.78% in June poll and 2.93% in December.

Managers have good reason to curb their default expectations. After all, default activity slowed in recent months after a relatively busy second quarter. Between July 1 and Sept. 17, just one S&P/LSTA Index issuer defaulted on $178 million of institutional paper: Contec. In the second quarter, by contrast, two large-scale bankruptcies – Hawker Beechcraft and Houghton Mifflin – pushed loan defaults to a 2.5-year high of $4.4 billion. With bankruptcy activity down in recent months, the default rate eased to 1% as of Sept. 17, from 1.04% at the end of June. What’s more, the annualized default rate for the first 8.5 months of 2012 fell to 1.41%, from 1.93% during the first half of the year.

Looking ahead, few loans appear vulnerable to default during the home stretch of 2012. LCD’s shadow default rate – a measure of loans to issuers that have either missed a bond payment, entered a forbearance agreement, or engaged bankruptcy counsel – illustrates the point. In mid-September it stood at a record-low 0.16%, unchanged from August.

When training their lens on 2013, participants say the outlook is cloudy. Clearly, much depends on market liquidity and the strength or weakness of the U.S. economy. Assuming the economy continues its sluggish growth, managers generally expect default rates to revert toward, though not to, the 3.4% historical average. The increase, they predict, will not be broad-based, but rather will be concentrated among a handful of large troubled situations. If so, 2013 will follow 2012’s script. In fact, Hawker Beechcraft and Houghton Mifflin together account for 80% loan default volume so far this year.

The empirical numbers support this view. Among performing loans in the S&P/LSTA Index, 4.2% now fit the statistical watch-list profile – those rated CCC+ or lower and bid at 70 cents on the dollar. TXU dominates this list of vulnerable names:

More broadly, managers say the general population of leveraged loans remains healthy, and, absent a shock to the system or a recession, will continue to perform well.